The Fed Just Disengaged Its Volatility Suppression Machine

The , published yesterday, reveals that the central bank intends to start reducing its balance sheet by $95 billion per month from May. Investors should pay close attention to this development because, for a very long time now, the Fed has effectively used its asset purchase program to suppress a variety of markets, including the .

When the Fed has removed this volatility mitigation system in the past, it has regularly led to a series of ongoing turbulence in the broader stock market. The most recent of these was the 2018-2020 period which began with the Volmageddon episode and ended with the COVID crash upon which the Fed massively re-engaged its volatility suppression program.

Fed ROC and VIX 6-Month Balance Sheet, 6-Month Average Chart
Fed ROC and VIX 6-Month Balance Sheet, 6-Month Average Chart

Considering that the magnitude of this turbulence has increased with each subsequent removal and/or cancellation of the asset purchase program, it stands to reason that the biggest burst of volatility could yet lie in wait.

As Christopher Cole said:

“Risk cannot be destroyed, it can only be displaced in time and redistributed in form.”

It is possible that Fed policy over the past decade, rather than destroying risk, has only succeeded in shifting risk forward. Now that rapidly rising inflation is making continuation of the program unsustainable, these risks could finally materialize in ways we have yet to see. At the very least, it could mean that stock market volatility could be high for the foreseeable future.

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